A balance sheet is a type of financial statement that shows the assets and liabilities of a business as of a particular date. It is one of the three primary financial statements used to assess a company’s performance, the other two being the income statement and cash flow statement.
Investors and other stakeholders can use a balance sheet as a reference to learn more about an organization’s financial situation. It allows them to compute the rate at which the business generates returns or assess the liquidity of the enterprise by comparing current assets and liabilities. A company’s growth can also be demonstrated by contrasting two or more balance sheets from various eras.
Stakeholders can also comprehend the company’s prospects with the help of this information. For instance, when a business applies for a loan, the balance sheet can be used as evidence of creditworthiness. Creditors can determine the company’s ability to pay short-term debts as well as the level of financial risk it is taking by comparing current assets to current liabilities.
A Balance Sheet: What Is It?
A balance sheet is a type of financial statement that shows the assets, liabilities, and shareholder equity of a business at a particular point in time. The foundation for calculating investor rates of return and assessing a company’s capital structure is its balance sheet. Financial ratio calculations and fundamental analysis can be performed on balance sheets in conjunction with other significant financial statements.
Important parts and elements of a balance sheet
Liabilities and assets are the two primary sections of a balance sheet.
Assets
Anything that a company owns and that helps the business grow is considered an asset.Assets, on the other hand, can be classified based upon purpose of usage, presence or absence of physical nature and its ability to be traded or delivered in non monetary form.
Convertibility: This means how easy it liquidates an asset into monetary form. Convertibility further divides assets into two independent categories, namely current and fixed.
- Current assets refer to any types of assets that can reasonably be converted into cash or for commercial purpose within 12 months. Examples of these are stock, marketable securities, and short-term deposits.
- Other forms of assets that cannot be so readily or immediately converted into cash are referred to as fixed assets. For instance, they are various models of mechanical environment resources, which can include structures, tools, machinery, or brand names.
Physical existence: Six types of assets are categorized into one group – the ‘intangible’ and another category is known as tangibles.
- Tangible assets are things like office supplies, machinery, equipment, and buildings that you can see and feel.
- Property such as trademarks, patents, and copyrights that do not physically exist.
Usage: There are two types of assets: operating and non-operating.
- Operating assets are those that are required to carry out business operations. Buildings, machinery, and equipment, for instance.
- Assets classified as non-operating include marketable securities or short-term investments that are not required for day-to-day operations.
Accounts Payable
What the business owes to third parties are known as liabilities. This covers obligations about money that result from business dealings, such as debts. Businesses resolve their debts to the other party by returning the favor in cash or by rendering a comparable service. The balance sheet’s liabilities are shown on the right side.
However, this relates to liability as current or noncurrent under the circumstances.
- Current liabilities: These are short-term commitments or debts whose long period to be paid off is below one year. Current liabilities are also known as short-term assets such as accounts payable, interest payable, and short- terms loans.
- Non-current liabilities: These are commitments or debts with longer than a year until their due date. Bonds payable, long-term notes payable, and deferred tax liabilities are examples of non-current liabilities, also referred to as long-term liabilities.
Owner’s Share of Profits
Total assets less total liabilities equals owner’s equity. Put another way, it’s the amount that can be distributed to shareholders following the settlement of debts and the liquidation of assets. One of the most popular ways to show the company’s net worth is through equity. Retained earnings, or a set portion of shareholder equity that must be distributed as dividends, make up a portion of the equity.
Either a positive or negative equity value is possible. A positive shareholder equity indicates that the company has sufficient assets to cover its liabilities. Liabilities exceed assets if it is negative.
General account hierarchy on a balance sheet
Generally Accepted Accounting Principles (GAAP) mandate that current assets and liabilities be listed separately. Similarly, current and long-term liabilities need to be shown differently. Long-term asset accounts comprise long-term investments, fixed assets, and intangible assets; current asset accounts comprise cash, accounts receivable, inventory, and prepayments.
You may have long-term debt, interest payable, salaries, and customer payments under your current liability accounts, and long-term liabilities include bonds payable, pension fund liability, and long-term debt.
Liabilities will be arranged in ascending order, and asset accounts will be noted in descending order of maturity. Accounts are grouped under shareholder equity in descending priority order.
Equation and formula for balance sheets
The accounting equation, which has assets on one side and liabilities and shareholder equity on the other, balances out to form the balance sheet equation. Liabilities plus shareholder equity equals assets. The equation states that a business can pay for its assets by taking equity from investors or shareholders or by borrowing money as a service (liabilities).
Conclusion
When evaluating a company’s financial situation, investors and other stakeholders should consult the balance sheet. This document provides specifics regarding the assets and liabilities for the specified period. One can comprehend the performance of the company by using these details. Through balance sheet analysis, business owners can maintain a stable financial position for their enterprise.
You can take a closer look with an example of how to read a balance sheet now that you have a general understanding of how values are recorded in various accounts on a balance sheet. We will talk about various scenarios in this article to help you understand how values show up in the accounts on the balance sheet.